Why do companies globalise_

BUS3035 Molly Anna Bennett
22nd
January 2016 Word count: 2,114
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Why do companies globalize? Discuss with reference to key theories in this area.
Introduction
This paper will critically discuss why companies choose to globalize by looking at four key theories in
particular, providing relevant examples to demonstrate this. There is no official definition of globalization,
however, there are three main ideas that share a common concept. The first is the economic phenomenon in
that a widely used globalization definition is ‘the increasing interaction, or integration, of national
economic systems through the growth in international trade, investment and capital flows’ (Talloo, 2007).
This is generally the idea that companies buy from one another overseas and set up subsidiaries away from
their home country. The sociological perspective focuses on the process of globalization in that there is a
‘rapid increase in cross-border social, cultural and technological exchange’ (Cohen, 2015) primarily
concerning the human and cultural element. A more conceptual approach is to look globalization as ‘time-
space distanciation’ where social systems are stretched across time and space and those two factors are less
important when communicating (Giddens, 1984). All three have an underlying foundation that time and
space are no longer obstacles in human interaction, partly due to the introduction of various technologies.
Critically discussing and analyzing why companies globalize, this paper will take a viewpoint from neo-
classical economic, market power, product life cycle, and eclectic theory.
Neo-classical economic theory:
Primarily concerned with profit maximization, neo-classical economic theory has three main underlying
principles regarding why companies globalize. These are to efficiently allocate resources to retrieve the
best return on investment, respond to consumer demand and not manipulate the markets themselves and
choose locations based on low production and labour costs.

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According to Buckley and Casson (1976), a concept of foreign direct investment is ‘to choose locations for
their constituent activities that minimize the overall costs of their operations’. Dunning (1993) also follows
this and notes that there are three main primary motivations of FDI, one of which is efficiency, where
investors seek lower cost locations for operations, in particular the search for lower cost labour. In the
years 2002 to 2003, Dyson increased its profits from £18m to £40m. James Dyson puts this down to the
fact they moved their operations from the UK where wages were high, to Malaysia, where they were
significantly lower (The Guardian, 2003), proving that this can be a reason why companies globalize.
However, this ideology fails to acknowledge the fact that some countries are clearly more attractive to
investors than others. For example, China has often been described as ‘sucking away’ jobs from other
South Eastern economies such as Taiwan, Hong Kong and Korea. There is often a ‘race to the bottom’
where developing countries compete with one another to charge low labor costs and attract FDI in the first
place (Greider, 2001). Some countries in the South East specialise in different industries; China is often
known for its manufacturing sector, and India has a reputable status within the services sector. This idea
isn’t taken into account with neo-classical economic theory as the focus is solely on profit, not competitive
advantages that countries may have.
This theory identifies that instead of companies bulldozing into countries, they follow demand where
necessary and appropriate. India’s disposable income per person has increased recently; with a growing
middle class and wealth per person they are now able to afford more luxury goods and now demand these
types of products. In 2013, 30,000 units of luxury cars sold in India (Ahuja, 2014) with brands such as
Aston Martin and Bentley competing with one another, proving they have moved into countries to meet
this need; following neo-classical economic theory. The idea of FDI flowing from developed to developing
countries, where costs are low, can be undermined when referring to regionalization. Creation of the
European Union in 1993, and the North America Free Trade Agreement in 1994 proves that this is not the
case, and capital can move from developed to developed countries. Instead of countries operating

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individually, the structure of the global economy is changing; states are collaborating and promoting trade
liberalization. Argued by some, these regions are seen to divert trade from low cost non-member countries
back to where costs are higher (Krugman, 1991).
Market power theory:
Hymer’s (1960) market power theory is one centered around imperfect competition in a market that not
everybody is operating at an equal level, as the local businesses have advantages in terms of culture,
language and legal system. Overseas companies also have the risk in terms of foreign exchange and trading
in different currencies. Companies globalize to offset these disadvantages using market power to make the
investment profitable. It is suggested that companies from Western countries often superior technology or
managerial expertise (Kindleberger, 1969) and globalizing meant they didn’t have to compete in their
domestic market and could fully exploit this. In addition, from a Marxist’s perspective, the market power
theory could be interpreted that once a company has saturated its domestic country, it then moves overseas
to exploit others.
There are many advantages that multinational and transnational companies would have over those in
developing countries. One of which, a vital element in order to obtain other advantageous aspects, is access
to capital. More developed countries, typically in the West, have a lot of methods to retrieve capital for
their business and take advantage of these. Atkinson et al. (2010) argues that we are at a time of increasing
number and complexity products on offer within the UK, meaning businesses are likely to find a facility
that matches their operations. Generally, finance in developed countries is much cheaper because of lower
interest rates attracting potential businesses to facilities in order to grow. Having a resource such as capital
allows a business to build on other advantages to enter a market such as branding and marketing strategy
and also utilising economies of scale. There are many benefits to being able to use and afford economies of
scale. One is that goods can be purchased in large volumes, reducing the cost per unit to either pass this
saving onto the customer and offer a lower price, or have a good profit margin. Even though purchasing

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large amounts of products would mean spending some capital on a stock inventory, the company would be
able to replenish stock on a continual basis and meet customer demands. Capital can also be spent on
branding to increase recognition and hopefully establish loyalty.
Like the neo-classical economic theory, the market power concept demonstrates the flow of investment
from developed to developing countries; not from developed to developed, which as established, happens
on a regular basis because of regionalization. The market power theory ignores why some developing
countries are chosen over others. A major factor contributing to these decisions is market access and tariff
rates that are placed on products. Fugazza and Nicita (2013) addresses this as some market access
conditions have been affected by bilateral trading agreements where tariffs are lowered for trading partners,
below the most favoured nation’s rate. This means that FDI could be attracted to particular countries
because they are being given preferential market access.
Product life cycle theory:
Vernon (1966) has pioneered a chronological and linear theory that shows why and when companies
globalize in relation to the product life cycle. There are four main stages to this cycle, introduction, growth,
maturity and decline, the first two of which shows demand increasing, and the last two beginning to fall.
The concept in terms of globalization is that at the introductory stage, companies keep production of their
products close in the domestic countries. Generally, new products are mostly introduced in the developed
economies, and are then exported to developed economies, as the infrastructure is not complete to produce
on a mass scale. As demand increases through the growth stage the product life cycle begins to hit its peak
and enter maturity, where it levels and decreases into decline. Similar to the Marxist’s view of market
power theory, once this market has saturated, trade will then move into developing countries, as tariffs may
be lower. From 1995 to their accession to the WTO, China’s tariffs fell from over 40% to 10% in some
cases (Branstetter and Lardy, 2008), clearly a pull factor for companies looking to globalize.

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The biggest flaw with this theory is that it does not apply to the globalization of service firms. Insurance,
consultancy, accountancy firms and more have all globalized and opened offshore operations to serve the
local market, which is to date the dominant form of service globalization (Borga, 2005). The dominant
model of service globalization also undermines neo-classical economic theory in that the primary reason
for moving overseas was not to reduce production and labor costs, but to extend operations.
This particular theory is too linear and prescriptive, suggesting that products take an evolutionary and
gradual journey through the product life cycle. There are many products that might not even reach the
growth stage of the cycle, or even enter the decline process such as commodity products. The elasticity of
oil means that as price fluctuates, demand doesn’t change, as it is a necessity for businesses across the
world. This product will never hit saturation, and never hit decline, unless it were to run out.
Eclectic theory:
First developed by John Dunning (1980), the eclectic theory synthesizes different concepts to take a
broader perspective as to why companies globalize. The three ideas he takes into account are the ownership
of assets, internalisation benefits and location benefits. The idea of the ownership of assets is that an
organisation may have developed a particular competitive advantage in the domestic market. For example,
the Ford production line was praised for its efficiency, eliminating waste along the production line (Bowen
and Youngdahl, 1998) and has now been developed and utilized across the world. If these companies
possess such competitive advantages, they should be able to use them overseas, whether that be, similar to
the market theory to balance markets, or to compete within the market.
It has been debated that the costs of FDI in the long term are less than maintaining a license with a third
party, and this is a reason as to why companies globalize. The assumption is that it is more beneficial to
produce internally than outsource. There are many risks when outsourcing services; some are jeopardising
knowledge of the product, quality offered and reputational risk if something unethical occurs (Kliem,
1999).

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Closely related to neo-classical economic theory, and some aspects of market power, the third aspect of
eclectic theory is location benefits. If a company moves some of its operations abroad, and possesses an
efficiency motivation towards FDI (Dunning, 1993), then as proven with the case of Dyson, reduced
production and labor costs could prevail. This also touches on the market access aspect in that when
companies move operations they are able to trade with reduced levies. For example, Toyota and Nissan
moving their productions to the UK allowed them to then trade within the European Union.
The eclectic theory is clearly very useful and a fundamental tool for analysis taking into account neo-
classical economic, market power and product life cycle theory. However, like all the theories discussed,
its primary concern is regarding efficiency benefits in the form of economic sanction. Any political power
that companies may have over governments or sources of capital such as banks, mentioned briefly in
market power theory and the idea of preferential market access, are not addressed (Cantwell and Narula,
2003).
Conclusion:
To conclude, this paper has clearly demonstrated why companies globalize using four prominent
ideologies. There are several different definition of globalization depending on what viewpoint is taken,
whether that be an economic, social or structural perspective. Which ever used, the common foundation
through all is that time and space are no longer obstacles to human interaction, largely with the help of
technology. We can communicate, trade and move quicker as a society. It is assumed that neo-classical
economic theory is primarily concerned with economic benefit from globalizing. This occurs by companies
rationally making decisions to outsource some services to countries with a lower production and labor cost;
maximizing profit for the business. Market power theory conveys that imperfect competition occurs in
foreign markets because of advantages such as local knowledge and language skills. To offset these, FDI
occurs in the form of market power. Marxists often identify that the sole reason to globalize in this case is
that the domestic market has saturated, and now they are pursuing other countries. Product life cycle theory

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takes a chronological viewpoint that products initially develop in the domestic country and this location of
production changes over the product life cycle. Production will often be moved overseas so the process
becomes simpler and more standardised, as a result, the unit cost drops dramatically. Eclectic theory a
much broader concept taking into account the ownership of assets, internalizing costs and location benefits.
It is important to acknowledge that every company globalizes for different reasons, it could be based on
one of these theories, or a mixture of all of them.

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Reference list
- Ahuja, P., 2014. Luxury cars: A new definition of necessity in India. International Journal of
Commerce, Business and Management, 3(2), pp. 260-268.
- Atkinson, A., Collard, S., Kempson, E., and McKay, S., 2010. Levels of Financial Capability in the
UK. Journal of Public Money and Management. 27(1), pp. 29-36.
- Borga, M., 2005. Trends in employment at US multinational companies: evidence from firm level data.
Washington DC: Brookings Institution.
- Bowen, D. E. and Youngdahl, W. E., 1998. Lean service: in defence of a ‘production line’ approach.
International Journey of Service Industry Management. 9(3), pp. 207-225.
- Branstetter, L. and Lardy, N. H., 2008. China’s Great Economic Transformation. New York:
Cambridge University Press.
- Buckley, P. J, Casson, M., 1976. The future of the multi-national enterprise, London: Macmillan.
- Cantwell, J. and Narula, R. 2003. International Business and the Eclectic Paradigm, Developing the
OLI Framework.
- Cohen, I. K., 2015. Economics for business: A guide to decision making in a complex global
macroeconomy. London: Kogan Page Limited.
- Dunning, J. H., 1980. Towards an eclectic theory of international production: in defence of eclectic
theory. Oxford Bulletin of Economics and Statistics. 41(4), pp.
- Dunning, J. H., 1993. Multi National Enterprises and the Global Economy. Wokingham: Addison-
Wesley.
- Fugazza, M. and Nicita, A., 2013. The direct and relative effects of preferential market access. Journal
of International Economics. 89(2), pp. 357-368.
- Giddens, A., 1984. Constitution of society. California: University of California Press.
- Greider, W., 2001. A New Giant Sucking Sound. The Nation. [online] Available at: <

http://www.thenation.com/article/new-giant-sucking-sound/> [Accessed 5 January 2016].
- Hymer, S. H., 1976. The International Operation of National Firms: A study of foreign direct
investment. Cambridge: MIT Press.
- Kindleberger, C. P., 1969. American Business Abroad. New Haven: Yale University Press.

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- Kliem, R. L., 1999. Managing the risks of outsourcing agreements. Information Systems Management.
16(3), pp. 91-93.
- Krugman, P., 1991. Is Bilateralism bad? International Trade and Trade Policy. Cambridge: MIT Press.
- Talloo, T. J., 2007. Business Organisation and Management. New Delhi: Tata McGraw Hill Publishing
- The Guardian, 2003. Dyson profits from Malaysian move. [Online] Available at: <

http://www.theguardian.com/business/2003/nov/08/4> [Accessed 5 January 2016]
- Vernon, R., 1966. International Investment and International Trade in the Product Cycle. Quarterly
Journal of Economics, 80(2), pp. 190-207.

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